Barbarians at the Power Plant Gate

Although it hasn’t attracted much attention outside the business pages, Energy Future Holdings, the largest utility in Texas, is going through the biggest bankruptcy proceeding since the collapse of Chrysler five years ago.

The story does not bode well for the future of American utilities. Instead it sheds light President Obama’s bizarre notion that the nation can shut down coal plants and replace them with “energy from sun, wind and soil” without suffering the kind of brutal economic consequences now being experienced in Japan and German.

Let’s set the stage here. In 2007, TXU Energy, Texas’s largest electric utility, announced long-range plans to construct 12 new coal plants to keep the lights on in the Lone Star State. All this, of course, was bemoaned by environmentalists, who are always telling us we are at the end of the era of fossil fuels.

So in stepped KKR, New York City’s premier private equity firm, run by cousins Henry Kravis and George Roberts, both long-time members of the Forbes 400. Just to refresh your memory, KKR was the main actor in Bryan Burrough and John Helyar’s 1990 bestseller, Barbarians at the Gate, which chronicled the presumed excesses of the 1980s and the firm’s winning bid for RJR-Nabisco, perhaps the country’s leading brand-name firm, after CEO Ross Johnson had tried to take the firm private. Outbidding both Johnson and legendary investor Ted Forstmann, KKR paid $25 billion in what was then the largest buyout in history. True, RJR-Nabisco did flounder under its enormous debt, but KKR emerged as the nation’s leading private equity investor.

Operating in Manhattan, however, KKR was also subject to all the winds of fashionable anti-fossil-fuel culture and global warming alarmism. So it decided to take action and play “green knight” with TXU. As head of a consortium that included TPG Capita and Goldman Sachs, KKR purchased TXU for $45 billion in 2007, changing the name to Energy Future Holdings. Environmental Defense and the Natural Resources Defense Council, two of the nation’s top three environmental groups, were brought on board to give the whole thing the proper imprimatur. Press releases at the time announced how the sophisticated New York company was going to enlighten those fossil-fuel-addicted Texans about the future.

Kravis himself promised: “We have developed a new vision with management of how we can turn TXU into a more innovative, customer-centric, environmentally friendly company.”

David Bonderman, the founding partner of TPG, opined: “With the support of the government and environmental leaders, TXU’s new approach will better manage the delicate balance between the energy needs of a growing Texas population, responsibility to the environment and the cost concerns of Texas businesses and residents.”

Rich Friedman, of Goldman Sachs, added: “This transaction serves as a model for long-term environmental stewardship. By investing in new technologies, encouraging conservation and reducing carbon emissions and pollutants, TXU is on the path to being a 21st century power company.”

The environmental participants were even more sanguine: “This is one of the most significant developments in America's fight against global warming,” announced Fred Krupp, president of Environmental Defense. Frances Beinecke, president of the NRDC, added: “This turnaround marks the beginning of a new, competitive focus on clean, efficient, renewable energy strategies to deliver the power we need while cutting global warming emissions.”

So what happened? Well, Energy Future did cancel eight of the 11 coal plants it had on the drawing boards. That made environmentalists happy. Within a few years, however, the Sierra Club, the other major environmental outfit, was in court challenging the operation of the company’s older coal plants. In 2013 the Club launched “Beyond TXU,” a Dallas campaign trying to get customers to switch to other utilities. As for all the talk of all the new strategies of clean coal and voluntary cap-and-trade, nothing much ever materialized.

The company did undertake some conservation programs and started building and buying power from windmills. Despite its image as an oil-and-gas state, Texas actually has the nation’s largest complement of windmills, which blanket huge swathes of West Texas. The trouble with wind, however, is that it is intermittent and needs to be constantly backed up. This is a grid operator’s nightmare because the shifts in output can be sudden and unpredictable. Voltage balances on the grid must be maintained within 5 percent tolerances or else there will be power lapses or power surges that can bring down the whole system.

But this in turn is a nightmare for the operators of coal and nuclear plants. Neither can be ramped up and down easily but are run best at a steady pace. (Nuclear is fairly inflexible and coal boilers can be damaged by too much fluctuation.) But with the advantages given to wind, that means the base-load plants are often unable to sell their power. The federal production tax credit gives windmills such favorable economics that they can often give away their electricity — or even pay grid operators to take it! — and still make a profit. This leaves coal and nuclear plants running at a loss whenever the wind blows.

The only generators that can be attuned to wind’s vagaries are combined-cycle turbines running on natural gas. In 2007 they did not appear to be too competitive because gas prices were so high. But when the fracking revolution cut the price in half, the combination of gas-and-windmills began eviscerating EFH’s profits. By last year revenues had shrunk to the point where EFH couldn’t even make its debt payments. For a time it appeared that KKR might be dragged under as well.

As for the environmental groups, they had long ducked for cover. Ralph Cavanagh of NRDC and Jim Marston Environmental Defense’s Texas office served on EFH’s Sustainable Energy Advisory Board but their contribution consisted of little more than making sure the company canceled its coal plants and promoting a few conservation efforts. The company’s finances were of no concern. In April the pair wrote an op-ed for the Fort Worth Star-Telegram praising EFH for its “continuous improvement in power generation’s environmental performance, capital investment, efficiency incentives for energy consumers and a deep commitment to land conservation.” Never mind that all this led to the tenth biggest bankruptcy on record.

In a revealing interview with Fortune this month, Warren Buffett commented, “[O]n wind energy, we get a tax credit if we build a lot of wind farms. That’s the only reason to build them. They don’t make sense without the tax credit.” That may be fine for billionaire investors but it leaves utility companies and their customers holding the bag. Germany is already finding this out as the country’s leading utilities reel under the burden of subsidizing so-called “renewable” sources. RWE, the second-largest utility, just reported a losing year for the first time since the founding of the German Republic in 1949.

In this country we are starting to close down perfectly good nuclear reactors because they can’t compete with the combination of subsidized wind and natural gas. Alternative energy enthusiasts crow this proves “the old utility model obsolete” — but that’s exactly what happened to the admirably forward-looking Energy Future Holdings.

The outcome of all this will be ever-more-expensive electricity. Germany now pays the second-highest rates in Europe (behind Denmark, which has even more wind). The same thing is about to happen here. California, which is further down this road than any other state, pays 50 percent more for electricity than its neighbors and manufacturing companies are rushing for the exits. More than half of California’s electricity now comes from natural gas — twice the national average — and gas is not going to remain cheap forever. Even some environmental groups are now expressing alarm that favoritism toward renewables may close down up to one-quarter of the nation’s nuclear reactors — which provide 60 percent of our carbon-free electricity.

Only Oklahoma has tackled the problem of making wind and solar providers pay a penalty for its intermittency. But of course this has set off howls of protest from sources as far away as the editorial board of the New York Times and set off another round of blame for the Koch brothers, who happen to live in Oklahoma. Still, the problem of oversubsidizing wind and solar is real and could easily lead to much larger consequences — just as oversubsidizing housing ownership led to the financial meltdown of 2008. Energy Future Holdings’ spectacular failure may only be the beginning for American utilities.

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